US slowdown is ‘little worry’ for software sultans

HYDERABAD: A US slowdown, if it does happen, may not necessarily translate into a major downside for the $30-billion plus Indian software services sector.

Fears of defaults on sub-prime mortgage loans held by high-risk borrowers, rising oil prices, higher-than-expected inflation rates, and falling US economic indicators last week have led to worries of a US economic slowdown.

The Conference Board, a respected non-profit body that watches the US economy closely, said its index of leading economic indicators fell 0.5% in February after a 0.3% drop in January. It points to the direction of the US economy over the next 3-6 months.

The Indian technology sector may have little to fear. Even in the worst-case scenario, contraction in technology-spend could be less than 10% compared with the 25% seen in the 2001-02 crash.

US tech spend this year is seen at $1 trillion, according to an HSBC Research analysis, based on the newly launched HSBC Technology Spend Index. A downturn may lead to some shrinkage in the overall market but software and services is a relatively stable segment and should see an even lower impact, says the survey of 480 top technology companies that figure in the Tech Index.

The Indian IT services industry derives almost 70% of its revenues from the US and how the economy performs is crucial to its growth. There are strong indications from the market of tech budgets going up by at least 15% in the US this year. This conclusion is also in line with the growing confidence in Indian vendors, whose track record and budget performance has led to greater acceptability and dominance in the global IT arena.

The confidence that tech budgets would not go down drastically also stems from a study of the figures during 2001-02, when even in the face of severe contraction, the IT contribution to GDP did not fall below 7.8%, with software and services showing positive growth. The cut in 2001 was also driven by a rationalisation of spend in semiconductor and communication equipments, which now contribute an even lower proportion of the total technology-spend in the US, says the study.

As per the HSBC Technology Spend Index, in 2001, hardware and communication equipment industries saw the sharpest decline in production. Software and communication services were relatively less affected, leading to a rise in their total contribution to the GDP of IT-producing industries.

The total contribution of software has further increased to 40% in 2006 from 36% in 2000 and 29% in 1997, it points out. On the flip side, however, in the short term, a slowdown could mean a freeze on pricing, lower sales productivity for vendors and consequently margin challenges, says HSBC Research.

How they will cope with this will depend on the software vendor and its position. Companies with strategic client relationships and strong domain understanding will be the winners.

However, larger and niche vendors are better placed than smaller ones to weather the storm in the event of a slowdown. The larger ones will also resort to aggressive acquisitions, particularly in Europe, during the year as a strategy towards this, the study says.

Technology companies have also expanded their geographic presence and reduced spending concentration on traditional segments.

Industry estimates show that companies are now spending their IT budget in the ratio of 40:20:40 for hardware, software and services with a higher proportion for software and services than earlier.

This has been coupled with a rebalancing of workforce indicated by the increasing presence of MNC vendors in offshore locations to align themselves to the emerging global delivery model after an initial mode of denial.

So much Indian IT workforce who accounted for less than 20% of the US software employees today accounts for 70% of the total, the study says.

This has been accompanied by lower increases in compensation for software engineers and analysts in 2002-05 with average increase of 3% y-o-y compared to 4% increase seen between 1999-02 and peaks of 8% in 1999-00.